Year-end financial planning: How to prepare for Biden's proposed tax changes

·4 min read

Right now, President Joe Biden’s new American Families Plan tax proposal is just that: a proposal.

But should it become the law of the land in its current form, there’s plenty of year-end financial and tax planning moves for taxpayers to consider now.

New top income tax rate. One provision would raise the top ordinary income tax rate bracket from 37% to 39.6%. Given that, higher earners should think about accelerating some of next year's income into 2021 to avoid higher rates proposed for 2022, says Philip Herzberg, a lead financial adviser with Team Hewins. “The change would apply above proposed $450,000 of taxable income for joint filers and $400,000 for single filers, which are much lower than current top rate beginning at around $628,000 for couples filing jointly and $524,000 for single filers,” he says.

Consider making Roth IRA conversions in 2021. Given the potential for higher ordinary income tax rates, Herzberg also recommends that IRA account owners consider making Roth IRA conversions in 2021. “By making the change now, traditional IRA distributions will be taxed at a lower rate than in the future,” he says. “While Roth contributions are made with after-tax dollars, growth and earnings of account assets are free of taxes. And future Roth IRA withdrawals or distributions are tax-free.”

Bunch deductions. If top tax rates rise in 2022, tax deductions would likely be more valuable to those with higher rates, Herzberg says. “With a higher $12,550 standard deduction for single filers and $25,100 for married filing jointly in 2021, it is more challenging to itemize and claim the write-off,” he says.

Herzberg’s advice: Think about deferring medical deductible expenses and concentrating or “bunching” their charitable donations into next year. “This front-loading of charitable gifts enables you to maximize your deductions and could generate higher tax savings than spreading out charitable gifts over two or more different tax years.”

Don’t let the capital gains tax tail wag the financial planning dog. It will be challenging to strategize for the proposed increase in the top rate on long-term capital gains to 25%, he says. For starters, it would apply as of Sept. 13, 2021. “Taxpayers with large unrealized capital gains would not be able to sell assets before 2021 year-end to avoid higher rates,” he says.

Herzberg’s advice: Achieving your goals, rather than changing tax laws, should primarily drive planning decisions. “Consider low-cost lending alternatives, such as home equity lines, or credit, or pairing sales with tax-loss harvesting if you need liquidity to fund short-term goals,” he says.

Prohibit Roth conversions for high-income taxpayers. Another provision would prohibit taxpayers with taxable income above $400,000 ($450,000 married filing jointly, $425,000 head of household) from executing a Roth conversion for an IRA or employer-sponsored plan.

The good news for these taxpayers is that the provision would not become effective until Jan. 1, 2032. That means taxpayers have a 10-year window to convert pre-tax accounts to Roth accounts and pay the tax upfront, he says.

Herzberg’s advice: Those who expect high income beyond 2031 should consider whether and how to benefit from Roth conversions before 2032.

Backdoor Roth IRAs. Under current law, taxpayers can contribute after-tax dollars to an IRA and/or 401(k) and then convert those dollars into a Roth IRA. Financial planners refer to these tactics as the “backdoor Roth IRA” and the “mega-backdoor Roth IRA.”

The proposed bill would prohibit conversions of after-tax dollars held in retirement accounts – both IRAs and employer-sponsored retirement plans, such as 401(k)s – beginning in 2022, notes Jeff Cutter, president of Cutter Financial Group.

What to do? Contribute after-tax dollars to your IRAs and 401(k) in 2021 and then roll that money over before the end of the year, says Gina Chironis, CEO of Clarity Wealth Management.

In addition, review and consider terminating all after-tax contributions into your employer-sponsored retirement plan, Herzberg says.

Reduction in the unified credit amount for estate and gift taxes. The gift and estate tax exemption, which is scheduled to revert from the current rate threshold of $11.7 million to its 2010 level (indexed for inflation) in 2026, would now revert three years sooner, to about $6.03 million starting in 2022. But a proposal touted by Sen. Bernie Sanders, I-Vermont, would lower it even more to $3.5 million per person.

Herzberg’s advice: Use this year's $11.7 million exemption to give money to heirs without concerns it will be clawed back if the exemption is reduced.

Chironis, for her part, recommends being cautious. “Don’t do too much estate planning before you know how this all shakes out,” she advises. Among other things, you’ll want to weigh the loss of a step-up in basis at death versus any estate tax savings gained by potential gifts to a trust, for instance.

Robert Powell, CFP, is the editor of The Street’s Retirement Daily and contributes regularly to USA TODAY. Have questions about money? Email Bob at rpowell@allthingsretirement.com


The views and opinions expressed in this column are the author’s and do not necessarily reflect those of USA TODAY.

This article originally appeared on USA TODAY: Taxes 2022: How you can prepare for Biden's proposed changes this year